Sunday, March 8, 2009
With countries around the world jointly fighting severe economic contractions, financial crises, and commodity price deflation, the outlook regarding public finance is dim into the medium term. The International Monetary Fund (IMF) released a report that looks at public finance over the short-term and medium-term for the G-20, The State of Public Finances: Outlook and Medium-Term Policies After the 2008 Crisis (the .pdf is available here).
This is a nice paper that sums up some issues regarding debt versus fiscal deficits. A first important feature of this recession, is that its severity (the huge output gap and rising unemplyoment rate) is one primary cause of the budgetary stress (deficits and rising debt) - rising unemployment insurance payments, social transfers, and falling tax revenues. The fiscal stimulus measures and response to the financial crisis simply add further stress to the fiscal budget, but likely mitigate the recession, and therefore further automatic spending.
And second, deficits usually fall during the recovery period, as the macroeconomy improves, stabilizing spending falls, and temporary stimulus measures wear off. However, debts must be actively paid off in the longer term.
The short-term fiscal outlook
The advanced G-20 fiscal deficits are expected to reach 8% of GDP on average in 2009, a 6% increase since 2007. The debt-GDP ratio is expected to rise another 14.5% as a share of GDP.
And the near-term impact of the economic crisis (recession) shows that automatic stabilizers will contribute a sizable share to rising deficits, alongside discretionary spending and financial aid.
The medium-term fiscal outlook
Fiscal imbalances are expected to improve, but may remain above pre-crisis levels. The deficits will fall due to the following: (1) improved macroeconomic conditions, (2) temporary stimulus measures wear off, (3) possible tightening measures like further reduced spending and/or tax hikes. However, debt-to-GDP ratios are expected to remain elevated, and in the U.S., debt is expected to rise to 99.5% of GDP.
That is only in the baseline scenario (page 21). The projection worsens markedly if growth is 1% below the baseline in 2009-2011, or if the G-20 experienced a Japan-style prolonged economic slump (growth falls 2% below the baseline 2009-2013).
Looks bad. But remember, so is this recession. And much of the debt accumulation (page 25) and deficit spending will be in direct response to the size and severity of the recession.
Overall the risks are great, and the outlook regarding debt growth across the G-20 is rather bleak. The IMF notes that rising government debt does not imply fiscal insolvency, as many countries will find ways to reduce the debt. However, it cannot be ignored, and must be addressed in expansion years.